Regardless of the reason, significant shareholder redemptions are among the least understood corporate transactions.  In this article, we consider the economics of family shareholder redemptions from three perspectives: the selling shareholder, the family business, and the remaining shareholders.

As family businesses evolve, the family’s leaders need to determine the appropriate relationship between membership in the family and ownership in the business. As the third, fourth, and subsequent generations of the family reach adulthood, it becomes increasingly likely that the interests of at least some family members will diverge from the interests of the business.

Family businesses can adopt one of two broad strategies to address this situation: (1) Maintain broad-based ownership and make positive shareholder engagement a strategic priority; or, (2) Use share redemptions and liquidity programs to achieve concentrated ownership among a subset of the family. Neither strategy is inherently superior to the other. We discussed the benefits (and challenges) of developing positive shareholder engagement in a prior article. In this article, we focus on the second strategy.

When we talk with family business owners, most confess a vague recollection of having signed a buy-sell agreement, but only a few can give a clear and concise overview of their agreement’s key terms. Yet no other governing document has such potentially profound implications for the business and for the family. My colleague of nearly twenty years, Chris Mercer, literally wrote the book(s) when it comes to buy-sell agreements. Chris and I recently sat down to talk about buy-sell agreements in the context of family businesses.

What should your family business’s distribution policy be? Answering that question requires looking inward and outward. Looking inward, what does the business “mean” to the family? Looking outward, are attractive investment opportunities abundant or scarce? Once the inward and outward perspectives are properly aligned, the distribution policy that is appropriate to the company can be determined by the board and communicated to shareholders.